When it comes to qualifying for a business loan, there is no one-size-fits-all scoring model. Lenders, banks, suppliers, and financing companies all employ different methods to assess the risk involved in loaning you. Whether you are a start-up or an established business, getting small business loans in the UK requires some paperwork. They cannot be approved the same day as short-term personal loans.
What are the factors that affect your business loan approval?
At the time of taking out a business loan, lenders will look at various factors. The most important ones are as follows:
- Creditworthiness
Not to mention, lenders will carefully check your creditworthiness. It is at the forefront of approval criteria. If your business has a separate legal entity, your lender will look at your business credit score. Otherwise, the lending decision is made after perusing your personal credit report.
Do not assume that lenders will not take a look at your personal credit rating because of a separate business entity. This is checked when you are required to provide a personal guarantee.
A credit score speaks volumes about your financial demeanour in the past. A bad credit rating suggests that you struggled with payments in the past, while a good credit rating implies otherwise.
Bear in mind that a history of missed payments can cause lenders to harbour suspicion of your repayment capacity.
Tip: try to monitor your credit report regularly. Sometimes, a poor credit rating is the result of errors. You can have them fixed by reporting to credit bureaus.
- Cash flow
No business can survive without a steady cash flow. Before approving a business loan, they will like to see if you have enough liquidity to make payments. There are various factors that lenders check in order to see how strong your cash flow is.
- Revenue streams – your business must have hit the breakeven point. You will likely have greater chances of getting approval when profits are consistent rather than fluctuating.
- Profit margins – healthy profit margins ensure that your business can survive when there are some unexpected changes in the market trends, such as dipped sales.
- A debt-to-income ratio – lenders will carefully evaluate how much debt you actually owe. Too much debt will call your credibility into question.
Tip: provide a detailed cash flow statement. If you are a start-up, you will need to submit cash flow projections.
- A business plan
A well-structured business plan is required if you are a start-up. This helps lenders understand your vision and mission. You will clearly inform your lenders of your product, market segment, target audience, marketing methods, and projected profits. In order to make a successful business plan, you must:
- Have a clarity of purpose. Lenders would want to know how you will use the funds. Business loans are restricted to a specific purpose.
- Prove that you know the market inside out. Having a thorough knowledge of the industry and competition builds credibility.
- Have a growth strategy. How will you hit the breakeven point and generate profits?
- Highlight contingency plan so your business can survive when there is an unexpected shift in the market.
Tips: show your lender how a loan will contribute to the growth of your business. If you apply for a business loan through a broker, they can help you with creating a solid business plan.
- Collateral
No collateral is required if you want to take out a business cash loan on the same day, but large business loans are subject to collateral. It remains a significant factor for limited companies. Most of the time, business loans are pledged against tangible assets such as equipment, a piece of land, machinery, inventory, etc.
The size and type of collateral depend on the loan. For instance, if you need money to purchase equipment, you do not need to put down an additional asset. The equipment you purchase itself serves the purpose of collateral.
Sometimes, collateral is not enough. Lenders often require a personal guarantee. It means you will be obligated to discharge the debt when your business fails. Contact a broker to gain clarity on when you need a personal guarantee and when you need collateral.
- Trading history
Lenders prefer to lend money to businesses that have been trading for some years. Traditional banks and lenders will require you to have been running your business for at least two years. Even if you are a start-up, your business must be at least six months old.
Some lenders will require you to have a trading history of at least one year. If your business has not reached the breakeven point, you cannot access a business loan despite running your business for more than six months.
The bottom line
A business loan application is approved if you have been generating consistent profits, have the desired trading history, and have strong credibility. Make sure that you carefully evaluate your repayment capacity. Since most business loans involve a personal guarantee, you will have to pay off the debt out of your pocket in case your business struggles. Contact a broker in case you are struggling to get approval for a business loan.
FAQs
- How can start-ups with a limited financial history get approval for a business plan?
Make sure you have a solid business plan, a strong credit history, and collateral. In addition, you will need to provide a personal guarantee.
- Are business loans available for subprime borrowers too?
Yes, you can consider applying for a business loan despite a bad credit rating, but there is no guarantee that a lender will accept your application. If you somehow receive approval, you will end up with high interest rates.
- Does a personal guarantee reduce interest rates?
No, the size of collateral and personal guarantee can never reduce interest rates. Lenders decide on interest rates after assessing the risk involved in loaning you.
- Do industry trends matter for a business loan approval?
Yes, lenders prefer to approve loans when the industry seems stable. Businesses from high-growth sectors such as AI and health tech are favoured more than risk-prone industries such as retail.
- How much revenue does my business need to generate to get a loan?
Revenue requirements vary by lender. There is no one fixed figure because your overall business condition will be taken into account. A business broker can help you know these requirements at the pre-approval stage.
Harry Kane is a financial writer and author who has covered wide topics related to business loans and finance for the last decade. He has been working as the Chief Contributor in finding out deals on various business finance products covered by Thebusinessfunds, a reputed business loan broker firm in the UK. The primary work of Harry is to analyse the loan requirements of various businesses according to their circumstances and affordability. He directly communicates with the loan aspirants and guides them to get the right loan matching their needs. He has a vast experience in finance writing, working with many major business firms in the UK. At Thebusinessfunds, Harry also used to write well-researched blogs covering the financial problems of business loan aspirants and providing relevant solutions. He is a postgraduate with MSc. in Banking and Finance.
